Savers not maximizing TFSA's potential

Canada’s tax-free savings account is approaching its 1st birthday, but there’s evidence many investors aren’t exploiting the TFSA’s potential to the fullest.

The tax-free accounts have been more popular than anticipated, with one in five households opening a TFSA in the last 12 months, a report by BMO Capital Markets found.

“In the short life of this vehicle it has been amazingly successful,” said BMO Chief Economist Sherry Cooper.

Canadians over 18-years-old can contribute up to $5,000 per year to a TFSA at any bank. Any unused contribution room accumulates and can be redeemed any time in the future. Both returns on and withdrawals from the account are tax-free.

But there’s evidence Canadians have been overly conservative with their TFSAs with 94% of holders keeping them in low-risk bank savings accounts or term deposits.

“That may well have something to do with the reduced risk appetite of depositors over the past 12 months in light of the financial crisis,” Cooper said.

As the BMO report stressed, TFSA contributions can also be invested in stocks, bonds and higher-yielding short-term deposits as well as Guaranteed Investment Certificates (GICs).

BMO Financial’s Director of Retirement Strategies Tina Di Vito said she disagrees with having the words “savings account” in the TFSA title at all, because it restricts the way Canadians use the tool.

“Instead, this is an investment account,” she said.

“I like to think of this as a grocery shopping cart where this shopping cart can hold a variety of investments.”

Introduced as a surprise addition to the 2008 federal budget to encourage savings, the TFSA was heralded as the most significant savings-related tax break since the introduction of the Registered Retirement Savings Plan back in 1957.

Like an RRSP, first time homebuyers can tap into a TFSA to come up with a down payment on a property. Unlike RRSP withdrawals, which have to be replenished within 15 years, the withdrawal amount from a TFSA for any home buying or renovation activity is added to future TFSA allowances.

And for higher-income earners, TFSAs offer an attractive way to reduce taxes on income-bearing assets and capital gains once RRSP contributions have been maxed out.

Seniors can harness TFSA power too. Canadians can keep paying into a TFSA after the age of 71, whereas with a RRSP that is not possible.

TFSA contributions are expected be robust again in 2010. On average Canadians are saving 4.8% of their income, up from 3.7% in 2008.